MARGINAL EFFICIENCY OF INVESTMENT: The anticipated rate of return on a capital investment project undertaken by a business firm. Businesses typically compare the marginal efficiency of investment, abbreviated MEI, on physical capital with interest rate returns on financial capital when deciding to undertake an investment project. Because different investment projects have different returns, businesses often have a range of alternatives projects from which to choose. Combining all projects throughout the economy gives rise to an investment demand curve relating investment expenditures to the interest rate.
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An increase in the willingness and ability of sellers to sell a good at the existing price, illustrated by a rightward shift of the supply curve. An increase in supply is caused by a change in a supply determinant and results in an increase in equilibrium quantity and a decrease in equilibrium price. A supply increase is one of two supply shocks to the market. The other is a supply decrease. A supply increase results from a change in one of the supply determinants. The rightward shift of the supply curve disrupts the market equilibrium and creates a temporary surplus. The surplus is eliminated with a lower price. The comparative static analysis of the supply increase is that equilibrium quantity increases and equilibrium price decreases.
Supply DeterminantsAn increase in supply can result from a change in any of the five supply determinants.
- Resource Prices: A decrease in resource prices.
- Production Technology: An increase in production technology.
- Other Prices: A decrease in the price of a substitute-in-production or an increase in the price of a complement-in-production.
- Sellers' Expectations: Expectations by sellers of a decrease in the price in the future.
- Number of Sellers: An increase in the number of sellers in the market.
Old to New
First, consider the simple comparative static analysis of the supply increase. The diagram at the right presents the Shady Valley market for Hot Momma Fudge Bananarama Ice Cream Sundaes. The equilibrium price is Po and the equilibrium quantity is Qo. This market equilibrium will, of course, persist until and unless a determinant changes, which is the nature of equilibrium. The particular change under scrutiny is an increase in supply caused by a change in any of the five supply determinants noted above.
Suppose, for example, that Professor Magnaminious, the leading expert on hot fudge sundae preparation, develops a breakthrough hot fudge sundae preparation process utilizing the Professor Magnaminious Triple-Dip Hot Fudge Wonder Machine. It is the sort of technological advance that is bound to increase the supply of Hot Momma Fudge Bananarama Ice Cream Sundaes. And when supply increases, the original market equilibrium is disrupted.
How is the Hot Momma Fudge Bananarama Ice Cream Sundae market affected? An advance in technology works through the production technology supply determinant to shift the supply curve rightward. Click the [Supply Increase] button to illustrate the rightward shift of the supply curve. The OLD market equilibrium is no longer equilibrium. A NEW market equilibrium is found at the intersection of the original demand curve and the new supply curve. Click the [New Equilibrium] button to highlight this result. The new equilibrium price is Pe and the new equilibrium quantity is Qe. Note that the price is lower and the quantity exchanged is greater.
Step by Step
Now, consider how this supply shock to the Hot Momma Fudge Bananarama Ice Cream Sundae market can be divided into six steps. While the directions of the changes may differ, these six steps apply to the comparative static analysis of other demand and supply shocks.
- First, a determinant changes. In this case, the Professor Magnaminious Triple-Dip Hot Fudge Wonder Machine induces a technological advancement in hot fudge sundae preparation. A determinant change ALWAYS starts the market adjustment process.
- Second, the determinant change causes a curve to shift. The technological advance increases the supply of Hot Momma Fudge Bananarama Ice Cream Sundae and causes a rightward shift of the Hot Momma Fudge Bananarama Ice Cream Sundae supply curve. Click the [Supply Increase] button to illustrate this shift.
- Third, the shifted curve disrupts the market equilibrium, causing either a shortage or a surplus. In this example, the increase in supply creates a surplus. While sellers are now willing and able to sell more Hot Momma Fudge Bananarama Ice Cream Sundaes, buyers continue buying the original quantity at the original price. Up to this point, they have no reason to change. Click the [Surplus] button to highlight this imbalance.
- Fourth, the market imbalance causes the price to change. In this case, the sellers are not able to sell all of the Hot Momma Fudge Bananarama Ice Cream Sundaes that they would like. As such, they are willing and able to sell Hot Momma Fudge Bananarama Ice Cream Sundaes at a lower price. Click the [Price Decrease] button to illustrate this result.
- Fifth, the change in price causes changes in both quantities demanded and supplied. In this Hot Momma Fudge Bananarama Ice Cream Sundae market, the lower price has the intended effect of increasing the quantity demanded--which is the law of demand. It also has the unintended effect of decreasing the quantity supplied--which is the law of supply. Note that while the change in the production technology supply determinant induces sellers to supply more at all prices, including the original equilibrium price, the price decrease subsequently causes the quantity supplied to decrease.
- Sixth, changes in the quantities demanded and supplied both act to eliminate the market disequilibrium. In this example, the increase in the quantity demanded and the decrease in the quantity supplied eliminate the surplus. The price continues to change as long as the market is out of balance with a surplus. The new equilibrium price at Pe is lower and the new equilibrium quantity at Qe is larger. Click the [New Equilibrium] button to highlight this result.
One of EightA supply increase is one of eight market disruptions--four involving a change in either demand or supply and four involving changes in both demand and supply. The other three single shift disruptions are demand increase, demand decrease, and supply decrease. The four double shifts are demand and supply increase, demand and supply decrease, demand increase and supply decrease, and demand decrease and supply increase.
SUPPLY INCREASE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 5, 2024].
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